Commentaries (some of them cheeky or provocative) on economic topics by Ralph Musgrave. This site is dedicated to Abba Lerner. I disagree with several claims made by Lerner, and made by his intellectual descendants, that is advocates of Modern Monetary Theory (MMT). But I regard MMT on balance as being a breath of fresh air for economics.

Friday, 11 May 2012

Banks aren’t lending to SMEs – boo hoo.

British politicians have over the last year or so been worrying about the reluctance of banks to lend to small and medium size enterprises (SMEs). I criticised politicians for this concern about a year ago here. It’s time to make some additional points on this topic.

In addition to politicians, Positive Money makes much of the fact that banks lend primarily to those purchasing property while failing to fund SMEs and socially desirable stuff like infrastructure. (Incidentally, I support Positive Money, but disagree with them on a few points.)

Investments made primarily or partially because of their social desirability are dead loss from the strictly commercial point of view (at least that’s certainly the case with the National Health Service and state education). Given that banks undertake to repay depositors about £100 for every £100 deposited, it is a BLATANT SELF-CONTRADICTION to expect banks to invest in loss makers. (To be more accurate, banks undertake to repay the original £100 possibly plus interest and possibly less expenses.)

As regards SMEs, much the same point applies: it is a SELF-CONTRADICTION to ask an institution to guarantee to return £100 per £100 deposited AND take significant risks.
In contrast, for those who want to take a risk, there are plenty of options: i) the stock exchange, ii) start your own business, iii) help a friend or relative with their business, iv) bet on a horse.

Banks INEVITABLY go for safe investments, like property. And even property has not proved safe enough over the last five years.

Frances Coppola makes a good job of attacking the “banks must lend more to SMEs” argument.

As pointed out above, it is fundamentally silly to expect an institution which guarantees to return money to depositors to take risks. But of course the way we’ve solved this problem so far is to have government guarantee banks. And for the naïve, that seems to solve the problem: banks can take risks while depositors’ money is safe. Problem is that that just means taxpayers are subsidising commerce. And it’s not the taxpayer’s job to do this.

A vastly more intelligent and logical solution to the above safety / risk conundrum is to make depositors come clean: that is, force them to decide between safety and risk taking. Put another way, depositors need to be prevented from having their cake and eating it (enjoying the rewards of risk without actually taking any risk).

And that can be done via the “two account” system advocated by Positive Money and others in their joint submission to the Vickers commission. (See “Step 1”, p.7, here.)

The two account system enables a depositor to EXPLICITLY allow the depositor’s bank to take a risk with their money. The benefit for the depositor is a better rate of interest. The drawback is that this is COMMERCE, and there is no obligation on taxpayers to rescue those who take commercial risks if everything goes belly up. That is, under the two account system, depositors who explicitly let their bank take a risk with their money do not get their money back, or don’t get all of it back, if everything goes belly up.

That two account system might result in far more money being allocated to SMEs than politicians wittering on about the subject.

Is more alcohol the solution to alcoholism?

Another fundamental absurdity in politicians’ concern about bank lending to SMEs is that we’ve just had a credit crunch caused by excessive and irresponsible borrowing (in case you hadn’t noticed). And the solution adopted by the authorities? Well it’s to cut interest rates so as to encourage more lending and borrowing. You just couldn’t make it up.

In particular, having lent irresponsibly, banks have learned their lesson. They’re more cautious about lending. Politicians, it seems, have not learned any lessons. Politicians think the solution for excessive lending and borrowing is yet more lending (to SMEs in particular).

Presumably politicians think the cure for alcoholism is to supply alcoholics with yet more alcohol. And the cure for someone with a broken leg? Presumably it’s to break the other leg.

Lenders need specialist knowledge.

Lending to an SME ideally involves a detailed knowledge of the particular business the SME is in. And the average British bank manager just does not have that knowledge. Thus loans to, or investments to SMEs will inevitably tend to come from specialist lenders: not bog standard high street banks.

For example, Siemens has set up a bank. Siemens clearly has a detailed knowledge of the business it is in.

As this Financial Times article put it, “Siemens often acts an anchor lender, prompting other banks to participate as they presume that the engineering group is better placed to judge the technological risks of a project.”

Less lending constrains economic growth?

A popular argument put by economic illiterates (aka politicians) is that less lending means less economic growth. This is also an argument put by banks when lobbying for less bank regulation. And politicians fall for the argument every time.

Well is blindingly obvious that less lending means less growth ALL ELSE EQUAL. But of course there is no need for all else to be equal. That is, given less lending, demand and growth can perfectly well be boosted by boosting plain simple old consumer spending and/or increased public spending.

That boosts firms’ order books, and for what it is worth, there is nothing that potential lenders like more than a firm with a full order book.

Crowdcube and Zopa do not a two account system make – to quote Shakespeare. Reason is that they are a minute proportion of the total “borrow / lend” market, plus doing business with C and Z is voluntary. In contrast, the two account system would be compulsory and cover the ENTIRE borrow and lend market – or at least would involve all deposit takers.

Reason for that is the under the current system, banks plus their customers can effectively rob taxpayers, as Mervy King pointed out. That is depositors can gain the advantages of lending to commercial entities via banks (i.e. get more interest than they otherwise would) while carrying none of the risks – the taxpayer carries the risk.

The two account system disposes of much of that cross subsidisation.

Re nationalisation, I don’t think nationalisation as such solves many problems (not that I’m strongly against it). I.e. the important point is to have a set of regulations that brings us the best possible banking system. Who actually owns banks is a minor point. Though obviously left wing “clause 4” enthusiasts will see things differently.

Non-peer reviewed (or only lightly peer reviewed) publications. The coloured clickable links below are EITHER the title of the work, OR a very short summary (where I think a short summary conveys more than the title).

i) The above is not a complete list in that earlier versions of some papers have been omitted. For a more complete list see here, and “browse by author” (top of left hand column).

ii) 7 deals with a wide range of alleged reasons for government borrowing, including Keynsian borrow and spend. 6 is an updated version of the "anti-Keynes" arguments in 7. 5 is an updated version of 1, which in turn is an updated version of 4.

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Nice picture.

For source, Google: TREASURY: LA LEGGENDA DEI BOND VIGILANTES!

Bits and bobs.

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I do like Stephanie Kelton’s MMT colouring book. Filling in the colours should be a compulsory for all those with mental ages below three - i.e. all those under three, and all politicians over the age of three -….:-)________

90% of Euro banknotes issued in Germany are never spent: they’re just hoarded!!!!________

Thinking aloud….free banking (advocated by George Selgin and others) comes to the same thing as full reserve banking, seems to me. Reason is that under free banking there is no deposit insurance, thus deposits at banks are essentially equity: so called “depositors” stand to lose their shirts just like shareholders. At the same time, under free banking, depositors who want total safety are presumably free to deposit money at state run savings banks like National Savings and Investments in the UK. And that is effectively full reserve banking: loans are funded via equity, while no risks whatever are taken with deposits that are supposed to be totally safe.________

This is a laugh. One of the biggest consumers of carbon based fuels in the world, the US Air Force, complains about climate change.________

Like many people, I'm getting increasingly tired of the censorship on Twitter. I've started moving to alternative sites like gab.ai and reddit. Obviously if the censorship gets much worse, I'll abandon Twitter altogether.________

Richard Murphy thinks he invented "Peoples' QE" (the idea that the state should print money and spend it in a recession). See last paragraph here.

Latest fashionable idea among the chattering classes is that central banks should promote environmentally friendly activities. So why not have CBs promote every other worthy cause, like education, health care, you name it? Reason is that having CBs stick their noses in sundry worthy causes is just duplication of effort. E.g. we can have any cut in CO2 emissions we want by simply imposing a sufficiently heavy tax on carbon based fuels, so why have a second lot of bureaucrats doing what an existing lot of bureaucrats can do at little extra administrative expense? Moreover, CBs are supposed to keep out of politics.

On the other hand it can well be argue that global warming is so serious that absolutely any method of cutting it is acceptable, however daft. Also there is some evidence that central banks' bond buying exercise has been skewed towards carbon based fuel producers etc. Certainly if CBs are to buy private sector bonds, the skew is not acceptable. However, buying private sector assets is silly way to impart stimulus. Reasons are in a long article coming up in a day or two. ________

According to this source, agricultural land in the UK changes hands for an average of £21,000 per hectare. Land with planning permission changes hands for £6million. Raving bonkers. I don't mind a finite markup when planning permission is granted, but that £6million is totally absurd. More land should be made available for building houses.

Actually I suspect that £6million figure is wrong: I've seen £1million and £2million cited quite often before, but not £6million. But even £1million is ridiculous.__________

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MUSGRAVE'S LAW SOLVES THE FOLLOWING PROBLEM.

The problem. Deficits and / or national debts allegedly need reducing. The conventional wisdom is that they are reduced by raising taxes and / or cutting government spending, which in turn produces the money with which to repay the debt. But raised taxes or spending cuts destroy jobs: exactly what we don’t want. A quandary.

The solution. The national debt can be reduced at any speed and without austerity as follows. Buy the debt back, obtaining the necessary funds from two sources: A, printing money, and B, increasing tax and/or reduced government spending. A is inflationary and B is deflationary. A and B can be altered to give almost any outcome desired. For example for a faster rate of buy back, apply more of A and B. Or for more deflation while buying back, apply more of B relative to A